Topic: Economics
Dwell In This! Observations on the current housing deflation, analysis of contributing factors, ideas on the importance of housing in the overall economy.by Gene DeNardo
(centrist liberal libertarian)
Friday, November 21, 2008
We all need a dwelling. At least, we all need some form of shelter. Bad weather can make us cranky and a dwelling, except for the most extreme weather, provides protection. It serves as a barrier to intruders, people who for one reason or another are not welcome in close proximity to ourselves. It is an enclosure for those welcome, our family and friends, etc. And it is a great base from which to carry out our lives.
Depending on your perspective, recent events have been either the "best of times" or the "worst of times" for our most common form of modern dwelling, the house. If you have a bulky principle and a high interest rate, your house has a value far less than its cost to you, the situation resembles a nightmare. If you have a good amount of equity, this complicates your predicament. On the other hand, if you have never been able to afford a home because of outlandish prices, the current conditions could be a match made in heaven. Finally, you might be able to call a place your own.
Though there is plenty of suffering to go around, taking the big picture into account, the recent sharp pricing decline is beneficial. The market, no matter how controlled, contorted and restricted, eventually seeks equilibrium. Common sense tells us we are closer to that now than we were just a few years ago. Of course, if you are facing foreclosure this is little solace.
The cause of this correction is both simple and complicated. Simply, there was and is too much money. The Fed, with its ever powerful hand, had delivered too much currency at depressed interest rates. Housing prices swelled, fueled by the extra cash, speculation that it couldn't possibly end inflated prices further, until all realized that housing prices had far exceeded the actual value of their utility. Since the house is a "real good" and the money was no longer representative of the "actual value" of the good, the price began its downward spiral seeking value.
I did mention that the Fed "is" delivering too much currency. Since this is what caused the initial inflation, the cycle could certainly start up again. But there are two obstacles, the money may not be being directed to the places where it is needed and no one is "looking" at the money in the same way. We have seen currency purchase assets that became incredibly inflated and then proceeded to deflate even faster. They have lost the "faith" that supports a "fiat" currency. So no matter what the statisticians say about "currency value", people don't value it or believe in it even as strongly as they did a few short years ago. Time flies when your money is having too much fun! Humans have short memories though and history could easily repeat itself.
Mortgage backed securities also did their part. And I don't mean the money that was lost in the transactions surrounding them. If there was fraud on the selling end, then the perpetrators should be prosecuted, if you or your company made some bad purchases, then the consequences must play out.
The packaging of these securities, in combination with copious currency, caused the mortgage vendors to concentrate on the deal rather than the substance of the deal. Profits were made on the transaction, commissions became more important than feasibility of loans. Quality took a backseat to quantity. It wasn't important if the loan was a good one, or if you profited on the loan itself, there was more money to be made packaging and selling the mortgages than securing an interest amount that would rationalize making the loan in the first place. This increased the amount and velocity of loans, which made more and more money available to the housing market which pushed prices artificially higher and higher.
To be honest, I don't believe there would be much reason to sell mortgages or mortgage packages in an economy with a fixed currency. With less currency, capital becomes in greater demand. A loan, no matter what kind, becomes a more thought out process. It needs to be a "better" loan. Goods and Services are of higher quality when they have more innate usefulness. Humans place a premium on quality and attempt to "retain" such. Therefore, there is a higher cost in the trading of higher value goods or services [naturally!] which reduces the amount of trade. On the other hand, this increased demand for currency capital can lower the demand and cost of other goods dependent on this capital, such as housing. Win, win situation!
Any government intrusion into the housing market usually creates the opposite intended effect. The government tries to subsidize housing by increasing the supply of money available to people who wouldn't normally be able to afford a home. Any input of capital into a market almost always drives prices upward. With the exception of those directly receiving the subsistence, housing becomes less affordable. A government agency might also subsidize the construction of the house by reimbursing part of the cost to the builder and passing the savings on to the homebuyer. At the least, the builder has more work; therefore his labor becomes less available and more costly, again increasing housing costs. Artificial demand for materials and land raises the resource costs.
It could be argued that the glut of subsidy created houses lowers the overall housing prices because of increased supply, but these houses are already filled with purchasers who wouldn't have purchased without the subsidy, so price is unaffected. The rental market however should experience some deflation as there would be fewer renters since they became purchasers.
When you tax something it becomes more costly. The part of property tax that is attributable to the house is a double edged sword. Not only does it add to the cost of the house, it also punishes whoever built the structure. By their labor the builder adds value to Society and the government lays claim to part of that value.
The land part of the property tax can actually be good. Although theoretically it raises the price it also promotes the use. With a land tax holding and speculating are costly, so owners more readily look to develop or sell. The problem is government taxes virtually all land below houses and virtually all partitioned lots but little if any larger tracts that would supply future development. Most open land falls under a "tax exemption" for forest, farm, and ranch or otherwise. Because of this, speculation is subsidized, holding of large tracts by investors and corporations is common and the result artificially restrains supply and drives up prices which again reinforces speculation. Crazy logic, tax the lot to promote its use and drive up prices, and subsidize the land stock to promote speculation and land hoarding and drive up prices. A bad side effect, land for farming becomes overpriced jeopardizing farming and driving up the cost of food.
You can deduct your housing interest costs. Nice? A very nice thing for banks, who are able to charge more interest [increasing the housing cost] because other taxpayers who rent or have high equity are subsidizing your deduction by paying higher taxes. When the future home owner asks the bank how much they can borrow for their house, the bank computes the interest deduction right into the equation. The loan amount is increased giving the buyer the option to spend more than would be possible without the deduction. Most Americans exercise their option. More money in the market, housing prices absorbs it and increase.
Zoning is bad? Not always. No zoning could become chaos. Bad zoning is just bad. Good zoning considers supply and doesn't let the supply of land become threatened, instead it locates the supply. It protects the housing stock by attempting to insure all neighborhoods are good neighborhoods. The problem with zoning is that it must be accomplished by humans who don't always have the ability to see the big picture.
A quick example of bad or lack of zoning; an oil refinery decides to locate in the middle of a nice neighborhood. The nice neighborhood quickly becomes undesirable. Yes, affordable [read cheap here] housing has been created, but nobody wants it. In effect, housing and land has been removed from the supply causing more demand and price increase. Also, stratification is a result. If there is a wide spectrum of neighborhood quality, where you reside represents your ability to afford and your status in Society. On the other hand, when a majority of the housing stock is desirable, value of the stock is high but cost is moderate. The wealth of all increases and equity results.
Zoning can also be accomplished by the workings of a free marketplace. For it to be successful, any loss of value entailed, such as the oil refinery example above, must be accounted and compensated for. In a truly free market that is not based on chaos or anarchy, the right of each individual to be free of harm or injury must be upheld. In keeping with that principle, the gain of one individual can not come at the expense of another without compensation that both parties feel is equitable. This defines a just and unforced transaction. How would this value be determined without the legal entanglements similar to what is commonplace today are beyond me? To sum this up, I believe beneficial zoning could be a welcome alternative to either random unjust development or the constant need for the judicial arm of the government.
Housing follows directly behind agriculture in importance to the human economy. We first need food and then a place to eat it. Once that is accomplished, housing should reflect the condition of the overall economy. Our nation runs the gamut from homeless sleeping in cardboard boxes to poor living in substandard dwellings to privileged residing in opulent mansions, at times within walking distance of each other. If this is acceptable, then we can go back to our cold beer and reality shows.
When housing reflects the overall economic condition is it said to be a "determined" factor. What we have witnessed is housing as a "determining" factor. It has become an overriding force in the economy due to interventions through subsidies and resulting control through monopolization. When strong outside forces seek and gain control of a market, those who utilize the commodity lose a comparable amount of control. The more control gained, the more powerful outside influences become and the more difficult it is to regain freedom of exchange. That said we should never let this prohibit us from striving to restore equity.
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The views expressed in this
article are those of Gene DeNardo only and do not represent
the views of Nolan Chart, LLC or its affiliates. Gene DeNardo is
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employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
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